Category: Chart of the Week

August Off to a Difficult Start

Since peaking late in the third quarter of 2018, U.S. equities have experienced large swings in performance. Following the worst December performance since 1931, the S&P 500 staged a dramatic rebound logging its best quarterly return since the first quarter of 1998. Equities continued their march higher culminating with the S&P 500 reaching an all-time closing high of 3,025.86 on Friday, July 26th. The year-to-date rally is attributable to a multitude of factors, however, a dovish pivot by the Fed and optimism around U.S.-China trade relations were key macro drivers facilitating the rebound.

However, fortunes quickly changed last week as the S&P 500 logged its worst weekly performance so far this year with a 3.1% drop and the sell-off continued into Monday with a steep one-day drop of 3%. Recent market volatility centers around changing expectations with respect to the economic outlook, market participants reconciling a smaller rate cut than was priced in, and an escalation in the trade war with China. U.S. officials had hinted throughout the year that a deal was close ­— and progress was being made — however that trade deal optimism is now in doubt. An additional 10% tariff on $300 billion worth of Chinese goods was announced last week and is set to take effect on September 1st. China retaliated by telling its state-owned companies to suspend U.S. agricultural imports and allowing its currency to fall to decade lows against the U.S. dollar.

Volatility is likely to stay elevated over the near-term as the economic and trade outlooks remain uncertain. Historically, August is a volatile month and on average the third quarter produces muted returns. It is worth noting that the S&P 500 still has a double-digit year-to-date return and is trading nearly 5% below all-time highs; whether or not the index remains in positive territory for the duration of 2019 will no doubt depend at least partly on how the U.S.-China trade issues play out over the next 5 months.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

The Fed’s First Post-Recession Economic Stimulus

The Federal Reserve’s two central aims are to keep unemployment below a 5% threshold and inflation near a 2% constant. This week’s chart looks at how the Federal Reserve addressed these aims as they cut interest rates on Wednesday, July 31st, 2019, for the first time since the 2008 Financial Crisis from a fed funds target rate of 2.25%–2.5% to 2.0%–2.25%. This well-telegraphed and long-expected 25 basis point cut signals a shift in the Fed’s monetary policy towards one of dovish1 stimulus after a period of hawkishness from 2015 to 2018 that saw the Fed raise the fed funds target rate nine times from 0–0.25% to 2.25%–2.5%. In conjunction with this rate cut, the Fed also halted the run-off of their balance sheet by restarting their reinvestment in government bonds, effectively infusing more cash into the economy to provide further support.

As shown in the chart, this latest interest rate cut occurs with unemployment well below their 5% threshold — which by itself shows that stimulus is not necessary, while inflation is lower than their 2% target — which by itself shows that some stimulus would not hurt. The reasons for the Fed’s cut include a persistently slow global economy, weak business earnings environment, high U.S. rates relative to low and negative rates2 set by other central banks, the fact that low unemployment has not been driving inflation higher, and potential threats to global growth including Brexit and the tariff escalation between the U.S. and several countries, such as China.

For more information, please reference our full newsletter on the topic.

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1 Dovishness is a term used to describe central banks and central bankers who want to provide economic stimulus to keep unemployment low by reducing interest rates, which makes it easier for businesses to borrow and therefore hire people because of greater economic activity. This is in contrast with hawkishness, which describes central banks and central bankers who want to slow the economy down in order to contain inflation by raising interest rates, which makes it tougher for businesses to borrow and therefore restrains prices because of less economic activity.
2 Negative interest rates have recently become more prevalent among German and Japanese short term bonds as those economies continue to languish and their governments continue to provide more stimulus.

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Venture Capital Benefits from Mega IPOs

The first half of 2019 has produced a number of high profile IPOs including Uber, Slack, Pinterest, Zoom, Beyond Meat, and Lyft. These IPOs have made it a very successful year for U.S. venture capital exits. While the absolute number of exits has remained slightly below the pace of recent years, this year’s exits have been larger, generating nearly $190 billion through the first half of 2019. This year’s second-quarter exit value alone has exceeded the annual amounts for the venture industry going back to 2006. IPOs have accounted for nearly 83% of the cumulative exit value so far in 2019.

This strong exit environment is likely to allow U.S. venture capital to repeat 2018 as the strongest area of performance within the broadly defined private equity market. While we expect the first quarter to provide strong returns, the second quarter is where we will see a significant increase in performance as IPO offerings ramped up in the spring/early summer. With a robust remaining pipeline of potential IPOs scheduled for the second half of 2019 and 2020 including Airbnb, Palantir, Robinhood, Postmates, and WeWork, we do not see this market cooling off much in the near-term. Regardless of which of these remaining high profile IPOs materialize this year, 2019 is likely to be remembered by investors as the year of mega IPOs.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

What to Expect from Global Equities?

Through the first half of the year, most U.S. and non-U.S. equity indices have produced double-digit returns. For example, the S&P 500 and MSCI ACWI ex U.S. indices are up 18.5% and 13.6%, respectively. On the surface, these large returns appear to indicate a healthy equity market. However, when we dig deeper, we find that multiple expansion ­— rather than fundamentals — has been the key driver of year-to-date returns. In fact, earnings revisions have been negative across the globe as analysts have downgraded their 2019 EPS estimates.

Why have equity returns been so strong during a tepid earnings environment? First, we think markets were likely oversold in 2018, leading to a bounceback this year. Second, central banks throughout the world have become more accommodative, including possible rate cuts in the U.S. and tax cuts in China. This shift in monetary policy has boosted equity investor optimism. Looking to the rest of the year, we have a cautious view on equity returns given the poor earnings momentum. Additionally, macro events like the Brexit and U.S.-China trade relations serve as potential potholes in the second half. Collectively, these risks suggest more modest equity returns in the second half of 2019.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

The Evolution of Private Credit

With roughly $48B of U.S. private credit fundraising taking place in 2018 ­­— surpassing 2008 levels of $42B — private credit has established itself as an up-and-coming leader within the alternative space. By 2023, private credit is estimated to reach $1.4T in AUM, becoming the 3rd largest alternative asset class. This kind of success has brought with it increased competition, robust inflows, rising pools of dry powder and an inflow of managers within the space, up from 31 managers in 2010 to more than 130 in 2018.

The growth of available capital in the private credit market has been substantial, but the growing demand for debt has kept the opportunity largely intact. Direct lending, which is more prevalent in the middle-market, has rapidly developed into a meaningful source of debt capital within the private equity (“PE”) ecosystem.

Since the global financial crisis, the leveraged loan market has become less accessible to middle-market companies as banks have generally stopped lending in this part of the market. The volume of leveraged loans held by banks reached roughly 30% in 2008 and has since declined sharply to less than 10% today. Coupled with a 48% drop in the total number of U.S. banks from 1998 to 2018, demand for direct lending has increased as U.S. banks have substantially withdrawn from the market.

In their relentless search for yield, institutional investors stepped up in a meaningful way vis-à-vis direct lenders, and while highly competitive right now, direct lending brings PE-style returns with heightened levels of downside protection. Because private credit investments can be approached in a defensive, risk-controlled way, private credit is especially well suited for late-cycle conditions, and with its higher coupons, robust cash flows, and lower risk profile, we can expect private credit to continue to grow at an accelerated pace and become a consistent component of an increasing number of institutional investors’ portfolios.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Russell Indices Incorporate “Uber” Exciting IPOs

It’s that time of year again! The end of June brings longer summer days and the annual Russell index reconstitution. The Russell 1000’s constituent rebalancing this month also brings the inclusion of a few recent high-profile IPOs, most notably Uber, Lyft, Spotify, and Beyond Meat. This means all investors holding a passive allocation to the Russell 1000 will soon hold shares in these companies.

The Russell’s methodology weights constituent allocations based on the free-float market cap, which only includes shares readily available to trade. We show here estimated weightings of these newly IPO’d constituents alongside some well-known peers of similar weights. Notably, Microsoft has overtaken Apple as the largest index constituent. Uber, while likely the largest IPO of 2019, is still dwarfed by these two behemoths and will ultimately not become a massive component of the index’s roughly 1,000 constituents. Similarly, while the top few constituents seem to hold outsized portions of the index, the index’s performance is not dictated solely by them as they are significantly outnumbered by over 900 names which contribute to performance.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Are Americans Swimming in Debt Again?

The eleven-year recovery since the 2008 financial crisis has been good for most Americans, allowing many to pay off debt and build a solid footing again. However, as this market cycle is getting a bit long in the tooth, investors are rightly concerned about areas of fundamental deterioration and whether the next recession might be lurking around the corner.

This week’s chart looks at the total amount of consumer debt in the U.S. The chart shows the aggregate amount of mortgage debt, home equity lines of credit, auto loans, credit card debt and student loans among U.S. households. We can see that in total, the amount reached roughly $13 trillion at the peak of the 2008 crisis, fell to a trough of about $11 trillion in 2013, but has now surpassed 2008 levels to about $14 trillion today, with especially high growth in the total student loan amount.

While nominal numbers can be informative, finance is the study of ratios, which can be even more insightful. If we divide the total nominal consumer debt amount by the U.S. population at key dates, we determine that total consumer debt was $24.93 per person in 2003, reaching a peak of $41.68 per person in 2008, dropping to a trough of $35.27 per person in 2013, but again surpassing 2008 and reaching an all-time peak of $41.77 per person today. Should we be concerned? While per person levels of consumer debt are concerning, consumer debt to GDP levels would tell a different story. Dividing the same total nominal consumer debt as shown in the chart by nominal U.S. GDP, we have 0.6x in 2003, 0.9x in 2008, 0.7x in 2013 and back to 0.6x today.

The two leverage ratios suggest opposing conclusions. While the per person leverage ratio is showing that we are worse off today than in 2008, the GDP leverage ratio is showing that we are just fine, with a consumer debt-to-GDP ratio that is nowhere near 2008 and more akin to 2003. Bottom line, this is telling us that our GDP is growing at a faster rate than our population, due at least in part to advances in technology that have raised productivity levels. However, the per person leverage ratio is showing that each American on average now has more debt than ever before, even more than 2008 levels, which bears watching for its potential impact on overall growth in the coming years.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

When the Experts Are Wrong

Since the end of October, the yield on the 10-year Treasury fell more than 1% and as of writing stands at 2.12%. The drop resulted in the yield curve inverting between the 3-month and 10-year maturities, and the 2-year yield is getting dangerously close to also surpassing the 10-year. This dramatic decline and inversion made investors nervous that a recession was on the horizon and caught most economists off-guard. In both 4Q and 1Q the 10-year yield ended lower than the average forecast from the Bloomberg consensus by about 0.4%. 2Q is on track to be even worse as the yield may fall below the forecasted low from the survey.

Towards the end of 2018, most believed the 10-year would rise thanks to continued growth and further rate hikes by the Fed. However, volatility and ongoing concerns about tariffs have pushed investors into safe-haven assets. This was further fueled by the weaker than expected job reports and most now believe the Fed will likely cut interest rates at least once before the end of the year. As a result, some institutions revised their forecasts for the remainder of 2019, going as low as 1.75% for the 10-year. That said, there is still a great deal of uncertainty and rates could just as easily rebound should we get more positive economic data, if the Fed chooses not to decrease rates, or if there is a resolution to the trade conflict. Overall, this serves as a reminder to investors that timing the market is an imperfect science and even experts can miss the mark by a wide margin. We continue to encourage clients to stick to their investment policies, invest for the long-term, and follow a disciplined rebalancing routine.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Tank on Empty? Proposed Tariffs on Mexico Will Heavily Impact the Auto Industry

On May 30th, President Trump announced via Twitter that the United States will impose a 5% tariff on all Mexican imports starting on June 10th. The White House added that this percentage could quickly escalate to 25% if Mexico fails to “reduce the number of illegal aliens” crossing border lines. This week’s chart displays the potential impact of these tariffs on the auto industry in both the United States and Mexico.

In the first quarter of 2019, the United States’ imports of motor vehicles and parts totaled $93.3B (bar chart). Out of this total, the United States imported a whopping $32.8B from Mexico, almost a third of all the United States’ imports in motor vehicles and parts. After Trump’s tweet, both the S&P 500 Index and the S&P 500 Consumer Discretionary sector fell sharply.

Looking at specific auto stocks (line chart), General Motors (GM) will likely struggle dealing with this tariff as GM is Mexico’s largest automaker and has 14 manufacturing plants located throughout the country. Ford could also struggle: approximately 10% of Ford’s vehicles sold in the United States last year were imported from Mexico. Overall, these tariffs are likely to raise auto prices and reduce profits of automakers, which is bad news for investors and consumers.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Has Supply Peaked for this Real Estate Cycle?

Deliveries of new supply (property stock) in the commercial real estate market appear to have peaked in 2018 across all major property sectors (apartment, industrial, office, and retail). Higher construction and labor costs, as well as positive net absorption (demand), particularly in the apartment sector, are keeping supply in check. These supply dynamics give us comfort that the next real estate slowdown will be less severe compared to the last two cycles when oversupply prior to a recession exacerbated the downturn.

Despite further moderation in returns, overall fundamentals (absorption, occupancy, fund flows) remain relatively healthy across the real estate sector. Real estate lenders are more risk aware and showing heightened levels of discipline in this cycle compared to the last cycle. Strong fundamentals coupled with tightened lender behavior and little to no expected interest rate increases in 2019 should lead to stable real estate pricing and cap rate spreads to U.S. Treasury yields. As a result, we expect total returns in the mid-single digits for core real estate with an emphasis on income growth (NOI) over appreciation.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.